Jumping aboard smaller funds can be rewarding because it’s easier for them to generate “alpha" when they still have the agility to move quickly in and out of prospects.

In unearthing some of Australia’s rising money managers during the past year, one theme that has emerged is the close ties that bind many of the start-ups.

LHC Capital – launched two years ago by
Stephen Aboud
, 50, and universally known as “Sheik", and
Marcus Hughes
, the 35-year-old son of a builder – is no exception.

Without any marketing, LHC has expanded from $12 million under management to $80 million through impressive net annualised returns of 21.7 per cent and annual volatility of only 9 per cent. In the year to June 2013 the fund delivered 27 per cent, which comfortably exceeded the ASX large cap and small cap indices.

When the Aussie sharemarket tanked 7.5 per cent in May and June, LHC was up. It claims a “high conviction" Australian equities strategy that typically involves holding 10 longs and 10 shorts.

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Lowy connection

Before setting up LHC, Aboud ran money for the Lowy family for 11 years. “I was working at Deutsche Bank in 1998 and got a call from
David Lowy
," he remembers. “I thought it was a prank and hung up. He called right back and said, ‘Mate, this is David Lowy – don’t hang up’."

The Lowys sold $500 million of Westfield shares in 1998 and were forming a family office, LFG Investments.

Aboud served on LFG’s investment committee and personally managed $200 million with a similar high conviction long-short approach.

He says he quickly worked out the Lowys were uninterested in relative returns, in contrast to traditional institutions.

“If the market was down 20 per cent and you were only off 10 per cent, David was not patting you on the back," he smiles.

The Lowys were singularly focused on capital preservation and producing actual returns.

Despite the family’s billions, Aboud says the sons inherited the strong entrepreneurial spirit their father brought to Australia when he arrived in 1952. “Yet they also have very good bullshit meters and say ‘no’ more often than they say ‘yes’, " he adds.

“But when they do say yes, they have no trouble putting large amounts of their capital into an idea. And because they look at investments as businesses rather than trades, they are right more often than not."

One of the toughest things was sitting alongside the client. “I’m running $200 million of your hard-earned cash, and we’ve just lost some," Aboud explains.

“Unlike other funds, I had to look my investor in the eyes every day, which is not always easy."

Investment partners

After leaving LFG in March 2011 Aboud set up LHC in May with a $10 million seeding from the Lowys, $2 million from the Salteri family, and $2 million of his own money.

LHC Capital was up 10.1 per cent after fees in the year to June 2012 while the ASX 200 was down 8.8 per cent and the ASX Small Ords Index, which is LHC’s peer universe, was off 18 per cent.

But when he went back to the Lowy’s in April 2012 to raise more money, he was told they were redeeming. LFG was withdrawing funds from managers in which they did not have ownership interests.

It was at this point Aboud approached Hughes, who was working as a portfolio manager at the $1.5 billion Caledonia Investments, and personally running $100 million.

They’d met when Hughes had pitched Caledonia co-investments to LFG, and held stakes together in the Chicago Board of Trade and the Australian mining accommodation supplier MAC Services.

Hughes had been introduced to Caledonia’s Will Vicars by Russell Aboud. He started his career with UBS in London in 2000 in mergers and acquisitions, and after three years was poached by the $15 billion US hedge fund, Citadel, to work on “risk arbitrage".

Hughes crossed paths with another Australian John Ho, who founded the $1.4 billion hedge fund Janchor Partners and has been profiled in this column, when he too worked for Citadel.

Bold ideas backed

“At Citadel I was one of six guys running a $1 billion portfolio," Hughes says. Citadel taught him to take “concentrated risk" and back bold ideas.

“My interview was an example," he says. “They asked me to pitch an idea and I did, on a German tyre company. They liked it so much they put $25 million into it on my first day and within six months it had doubled."

One negative was the unforgiving culture. “The joke was that you were allowed two losing positions and then you were cut," he says. “[Founder] Ken Griffin had this saying: ‘I paid for your MBA with your first mistake – don’t make a second’."

Caledonia encouraged him to “look five years ahead and think big". He learned “to dive deeper into understanding the nuances behind complex companies, what makes executives tick, and what drives the cash flows".

A drawback was the difference between “capital and labour". Equity was not widely distributed. “I wanted to be capital and pulling the trigger as a principal."

The Salteris upped their investment with LHC to $30 million in July 2012. It helped that Aboud had known Peter Fitzgerald, their chief investment officer, from their days at LFG.

Fees are relatively cheap for a hedge fund. LHC charges 1.5 per cent combined with a 20 per cent performance fee for returns above the bank bill rate.

Target zone

So what’s their edge? “A little like when those 300 Spartans took on the Persian army, we concentrate on only hunting in our target “zone", which is companies capitalised between $100 million and $1 billion," Hughes says.

“We’re good at finding complicated, under-researched entities where there is a pathway for inherent operating tailwinds to be monetised."

While they are both responsible for idea generation, Aboud focuses on portfolio construction and risk management. Hughes injects the bottom-up analytical firepower.

Thus far their marriage has worked, with total returns up more than 40 per cent net of fees.

Hedge funds are not for the faint-hearted. But they have a role to play in alleviating downside equities risk.